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Some public funds uneasy with fee disclosure

State proposals raise execs' fear of shutout by managers

Daniel Biss
Illinois state Senator Daniel Biss: ‘It is unsustainable for pension funds to not know the fees they are paying.’

Updated with correction

Measures in several states focusing on alternative investment fee disclosure are causing public pension plan executives to worry they could get shut out of the best funds if managers are unhappy with the requirements.

At least eight states have considered fee disclosure for alternative investments, according to the Washington-based National Conference of State Legislatures.

Two bills have passed, one in Washington and one in California, but neither requires as much information as the fee reporting template released by the Institutional Limited Partners Association in January.

The Illinois House is expected to see a bill in November that already passed the state Senate. Legislation also is pending in Louisiana and Rhode Island. Bills have failed in three states — Alabama, Kentucky and New Jersey, the NCSL data show.

The ILPA disclosure template details fees, expenses and carried interest. So far, 53 institutional investors have endorsed the trade association's form. And half of that group now requires their general partners to use it.

But some pension plan officials have opposed disclosure legislation, fearing that alternative investment firms will shut them out of their investment offerings if firm executives don't care to provide more information.

Illinois is considered to have one of the strongest transparency bills under consideration. It would require full disclosure on fees, including management fee waivers and clawbacks of fees due to limited partners. In May, the bill was amended to resolve problems voiced by state pension fund executives, said Illinois state Sen. Daniel Biss, a Democrat who sponsored the bill.

“I believe that the situation is untenable. It is unsustainable for pension funds to not know the fees they are paying,” Mr. Biss said in an interview.

Under the amended legislation, which incorporates portions of the ILPA template, reporting requirements would not kick in until 2019. In the meantime, the Legislature will create a task force with state pension funds holding the most seats. If the task force comes up with a better proposal, that could become a new law.

“It's giving them (the pension funds) a very significant shot,” he said. ”If the pension plans don't like this bill, (this gives them a way) to find a more palatable mechanism of achieving the same goal.”

If legislators decide the task force's approach is inadequate, the current requirements of the bill will become law, he explained.

National approach

David Urbanek, spokesman for the $44.6 billion Illinois Teachers' Retirement System, Springfield, said executives at the fund prefer a national approach. “ILPA is something that could work well in Illinois,” Mr. Urbanek said. “We don't want to see a hodgepodge of regulation all over the place. That could be as bad for investment opportunity as anything else.”

Mr. Urbanek added there is a need for increased transparency that “puts us on a level playing field.” He acknowledged Mr. Biss' bill contains ILPA requirements, but said fund executives don't want to “gum up the works” with a state-by-state approach. “ILPA is preferred,” Mr. Urbanek said.

Alternative managers hired for new commitments by Illinois TRS will be asked to use the template but it won't be compulsory and there is no timeline for when the pension plan will begin asking managers to comply, he said. “We recognize that there are differences with a lot of the private equity managers. Some have more extensive back offices than others and we will take that into account.”

In California, pension plans large and small opposed the legislation, urging lawmakers to soften the requirements. The original bill, nearly as strong as the Illinois proposal, would have required firms to report the total fees paid by the companies within a particular private equity fund. A weakened version is awaiting Gov. Edmund G. Brown Jr.'s signature.

The $193.4 billion California State Teachers' Retirement System, West Sacramento, had concerns about strong private equity fee disclosure requirements contained in an earlier version of the bill. CalSTRS officials argued that private equity firms declining to comply simply would no longer take on the pension fund as a client and estimated that a strong fee disclosure measure would cost the fund as much as $400 million in returns over time, Ricardo Duran, CalSTRS spokesman, said in an e-mail.

In May, the $19.5 billion Los Angeles Fire & Police Pension Plan opposed the California bill, arguing in a statement on its website that it “would require disclosure of sensitive information regarding the underlying position(s) of private equity funds,” which is considered proprietary information by the firms.

“Under existing state law, there are several private equity funds that have made the decision to exclude public pension plan investors within the state of California from investing in their respective funds due to disclosure requirements,” the statement said. “Passage of this law will most likely increase the number of private equity funds with such restrictions.”

Opposed requirement

The Los Angeles Fire & Police board also opposed a requirement that California public funds disclose information for all new commitments as well as existing investments if limited partnership agreements are amended. The requirement eventually was dropped from the legislation, and reporting requirements only apply to commitments made after Jan. 1. The bill now simply exhorts public plan officials to “undertake reasonable efforts” to obtain the same information for existing investments.

The final version of the California bill, which passed in August, also was amended to remove mention of the ILPA template and no longer requires general partners to use a standardized form of any kind. The bill only requires private equity managers to reveal the pro rata share of fees for each pension plan rather than disclose the total amount of fees paid by portfolio companies to the alternative investment manager.

Not everyone approved of the weaker bill.

Michael Flaherman, former board member of the $307.2 billion California Public Employees' Retirement System, Sacramento, pulled his support from the bill after it was “fatally weakened ... by removing the requirement for full disclosure of related-party transactions,” according to a June 26 letter of opposition he wrote to Richard Pan, chairman of the California Senate Committee on Public Employment and Retirement.

Mr. Flaherman added that the amended bill “would set back the cause of private equity transparency.” California public pension plans might believe that receiving pro rata information on the cost is substantially the same as full disclosure, but it is not, he argued.

“What they ... perhaps may not understand is that, most of the time, a private equity firm purchases a portfolio company with capital from multiple vehicles, only one of which is the capital from the private equity vehicle in which a California pension system is an investor,” he explained.

Private equity firms do not share with limited partners the portion of fees attributable to vehicles other than the one in which a particular investor has allocated capital, Mr. Flaherman wrote.

California Treasurer John Chiang sponsored the bill and his office worked with the investment staffs of CalPERS and CalSTRS, said Grant Boyken, Los Angeles deputy treasurer, in an interview.

“I wouldn't say it was watered down,” Mr. Boyken said. “We talked to stakeholders about what is workable and would be passed through the state Legislature.”

Template endorsement

Even though the ILPA requirement is not in the final version of the bill, CalPERS officials endorsed the ILPA's reporting template and require compliance from all alternatives managers, said Joe DeAnda, spokesman for the pension fund.

Earlier this year, CalPERS asked its general partners to release carried interest information and received a 97% compliance rate, he added.

The CalPERS board gave an earlier version of the bill qualified support because of some wording it wanted added concerning pension funds' fiduciary responsibilities, Mr. DeAnda said. The fiduciary wording was later remedied through amendments, he said.

Mr. DeAnda declined to comment further on the bill. He pointed out, however, that CalPERS no longer invests in venture capital because years ago a number of VC firms stopped investing with public pension plans over disclosure issues.

This article originally appeared in the September 5, 2016 print issue as, "Some public funds uneasy with fee disclosure".